Clearing Over-The-Counter Derivatives

Lost within the historical health care reform debate on Capital Hill is the quiet work in both the Senate and the House of Representatives where bills are being drafted and hearings are being held in connection with implementing new regulation on the over-the-counter derivatives trading market. One of the primary focuses in the proposed regulation is on reducing credit and systemic risk by requiring that over-the-counter derivatives be "cleared" through registered clearing organizations or agencies called "clearinghouses." The clearing of over-the-counter derivatives currently is addressed in three bills being debated in Congress, one from the House Financial Services Committee, one from the House Agricultural Committee and one from the Senate Finance Committee.

Many commentators believe that unregulated trading of over-the-counter derivatives, including credit default swaps and other complex vehicles contributed largely to the implosion of Lehman Brothers, Bear Stears, AIG and others precipitating the global economic meltdown.

As with all new regulation, in particular regulating an enormous over-the-counter derivatives trading market (measured in the hundreds of trillions), the "devil" is in the details. Many commentators, including my colleague Christian Johnson at the University of Utah S.J. Quinney College of Law, are dubious that Congressional adoption of legislation will reduce risk efficiently, rather worrying that such clearing will create legal uncertainty, loss of efficiencies, reduction of hedging effectiveness and increase costs, most of which will be difficult to measure and address.